VIX Futures Expect Volatility to Go Up, But Not Next Week

Saturday, 10 August 2013

When you look at the current VIX futures curve

VIX futures curve

… you will notice the almost-J-hook on the short end: There is almost zero premium on the nearest (21 August) contract over the spot – in spite of the following facts:

  • There are still 7 trading days (11 calendar days) left to expiration. Normally you see spot and front month on par on the last few sessions, maybe on the last Friday before expiration, but not on the Friday before.
  • Most people would consider the current VIX level (13-14) “rather low”. Sometimes there is zero (or even negative) premium of futures vs. spot when more time is left to expiration, but that is typically when the VIX is “rather high”, like 17 or 20.
  • It’s Friday close, which typically comes with downside bias for the spot VIX relative to the futures due to weekend repricing of SPX options (don’t worry if you don’t understand that, as it’s not the point of this post; the weekend effect is briefly explained e.g. here by Bill Luby and almost every Friday someone mentions it in the $VIX stream on Twitter).


Here is what the current futures curve shows regarding volatility expectations of market participants:

  • Market expects volatility to increase in the next months (there’s contango – not the steepest we have ever seen, but certainly steep).
  • The increase in volatility is not expected to happen before August expiration.

Front Month vs. Spot Premium in Previous Expiration Months

Let’s look at VIX futures curves on the Fridays 1.5 weeks to expiration in previous expiration months. The first point on the left is always the spot VIX, the others are futures prices (X axis = calendar days to expiration):

VIX futures curve 12 calendar days before expiration - all months since January 2013

The green curve is the current one. We can forget the two grey curves at the top (June and July) and only focus on the months with similar spot VIX level.

Front month futures premium over the spot VIX was much higher in January, February, March, and May than it is now in August:

VIX futures curve 12 calendar days before January, February, March, May, and August expirations

While long-term volatility expectations (the middle and the right end of the curve) were also significantly higher in January, the other curves look the same as the current one, only the front month premium is different.

One curve that looks more similar to the current one (although still with higher premium) is April:

VIX futures curve 12 calendar days before April and August expirations


You may recall the chart of spot VIX (if not, see below). It was the lowest (spent a lot of time in the 12 handle and even briefly dropped below 12):

  1. in March
  2. last week
Spot VIX chart, 2013

This is not a coincidence. The two expirations with the smallest premium over spot (time to expiration and spot VIX value being roughly equal) have been those following the periods with the lowest VIX values (April after the March VIX lows and August now).

How Volatility Expectations Are Formed

The proces of volatility expectations being formed in the market is of course very complex, with different market participants looking at different pieces of information and having different motivations. Nevertheless, if you want to simplify it, there are two key groups of factors:

  • Recent volatility (measured as SPX realized volatility or spot VIX value – they are closely related). Volatility tends to revert to the mean, but at the same time it has memory. Other things being equal, VIX dropping to 12 next week feels more likely when it has already been there this month, compared to some other time when it hadn’t been even below 15 in the last 3 years.
  • Upcoming fundamental and external factors. For example, many people now think that an increase in volatility is more likely in September due to possible changes in QE (some blogs and even some banks have recently recommended long exposure to the September VIX expiration, stating the Fed meeting as the headline reason). Upcoming macro data release calendar or seasonality can also be among factors affecting volatility expectations. For example, the year end or summer are generally considered light on volatility, while the autumn is considered slightly more likely to bring higher volatility. There is again some memory effect on this – for example people still remember the extremely high volatility in the autumn 2008 and based on that they can (knowingly or subconsciously) be biased to expecting higher VIX in September or October.

Of course, reality can (and likely will) differ from expectations, to one or the other side. August VIX futures final settlement can still be 25, but it can also be 12. Or the futures can (contrary to expectations) spike to 17 next week, but still settle below 13.

Maybe your own expectations are different than the market’s. That’s how trading opportunities are created.